Section 363 Sales and the FTC – Caveat Emptor

One of the historical attractions of the Bankruptcy Code as a vehicle for restructuring is the ability to sell the debtorâ€™s assets quickly, cleanly, and with finality pursuant to a sale under Section 363.

So-called â€śsection 363 salesâ€ť have been the subject of much recent interest and debate, as evidenced by the discussion surrounding 2009â€™s â€śsection 363 salesâ€ť of both Chrysler LLC and General Motors Corporation (see, for example, blog posts here and here).Â In California, the effectiveness of such sales has been limited where the assets are worth less than the aggregate liens against them, and a lienholder objects to the sale.

Earlier this month, â€śSection 363 salesâ€ť received yet another potential challenge in California, this time from the Federal Trade Commission, which sought to undo Laboratory Corporation of America (â€śLabCorpâ€ť)â€™s acquisition of Westcliff Medical Laboratories, Inc. (â€śWestcliffâ€ť).Â According to the agencyâ€™s December 1 complaint to enjoin furtherance of the merger, filed in Washington DC and transferred to Californiaâ€™s Central District (redacted copy available here), the merger will substantially lessen competition among providers of capitated clinical laboratory testing services to physician groups in southern California.

LabCorp and Westcliff are clinical laboratory testing companies serving physician groups here in Southern California.Â In May 2010, Westcliff agreed to sell substantially all of its business assets to LabCorp for $57.5 million.Â As part of the sale, Westcliff agreed to file a voluntary petition for relief under Chapter 11 of the US Bankruptcy Code.Â The transaction was therefore subject to the approval of the US Bankruptcy Court for the Central District of California.Â In June, after a hearing at which no other bidder emerged to top the LabCorp offer, the court approved the sale, the parties closed the deal, and life went on â€“ until the FTC stepped in.

Though after-the-fact challenges to mergers are not unknown, they have been â€“ at least until recently â€“ comparatively rare.Â Even rarer is the challenge to an acquisition completed with approval by the US Bankruptcy Court.Â The FTC claims Westcliff wasnâ€™t a â€śfailing firm,â€ť whose assets otherwise would have exited the market absent the merger (and would therefore be exempt from anti-trust enforcement).Â Instead, the FTC alleges Westcliff was generating operating profits at the time of its sale and that there were other potential buyers available to purchase the company.Â According to the FTC, the reason these buyers didnâ€™t show up was because none would have matched LabCorpâ€™s $60 million â€śstalking horseâ€ť bid.

Counsel for LabCorp attempted to preempt the FTCâ€™s action by filing an adversary complaint in Bankruptcy Court, seeking declaratory relief as well as an injunction against the FTC, arguing that the agencyâ€™s enforcement action constituted a â€ścollateral attackâ€ť on the Bankruptcy Courtâ€™sÂ prior sale order.Â The FTC responded with its own motion to dismiss and an argument that its enforcement action was limited merely to prospective violations of antitrust laws, and did not seek to disturb the bankruptcy sale.Â Bankruptcy Judge Theodor Albert abstained, and transferred the matter to the US District Court where the FTCâ€™s action remains pending.

Though the Bankruptcy Courtâ€™s order authorizing the Westcliff acquisition remains undisturbed, the FTCâ€™s action raises some important and often-overlooked questions about â€ś363 salesâ€ť:Â Does counsel advising on the sale or purchase of a distressed business need to conduct or provide due diligence on the potential anti-trust effect of the transaction, despite the transactionâ€™s failure to meet the Hart-Scott-Rodino reporting threshold?Â Is it necessary (or good practice) for bankruptcy counsel to obtain factual findings commensurate with the sale which would insulate the transaction from subsequent attack?